California legislative analysts urge lawmakers to slow spending plans

The Legislative Analyst's Office released an estimated surplus that is roughly half of the $76 billion figure projected by California Gov. Gavin Newsom in his May budget revisions.

• The state has $38 billion of discretionary state funds to allocate in the 2021-22 budget process, according to the report penned by LAO budget analyst Ann Hollingshead released Monday.

The governor gave his estimated surplus numbers last week ahead of revisions to his $267.8 billion spending plan for the 2021-22 fiscal year.

“The governor’s estimate includes constitutionally required spending on schools and community colleges, reserves, and debt payments,” Hollingshead wrote. “We do not consider these spending amounts part of the surplus because they must be allocated to specified purposes.”

California Governor's Office

The $76 billion surplus estimate out of the Department of Finance includes “the total amount of new available resources for schools and for reserves,” said H.D. Palmer, a DOF spokesman, adding that the LAO notes in its comments that if those amounts are excluded, the estimates are nearly the same.

He declined to expand on why the DOF believes it is OK to include money restricted to certain spending uses in the surplus, while the LAO does not.

The LAO also recommended the Legislature restore budget resilience noting the governor uses $12 billion in reserve withdrawals and borrowing to increase spending, a tool used during last year’s budget process because of an anticipated $54 billion deficit amid pandemic pressures.

“The state will need these tools to respond to future challenges, when federal assistance might not be as significant,” Hollingshead wrote. “We urge the Legislature not to take a step back from its track record of prudent budget management.”

The DOF agrees “with the LAO that budget resiliency is critical — which is why the May Revision includes a total of $24.4 billion in combined budget reserves,” Palmer said.

“At the same time, the state has not only immediate needs but well-defined infrastructure needs as well,” Palmer said. “We believe the May Revision strikes a proper balance, and we’ll work with the Legislature in the coming weeks to further discuss how best to balance these imperatives.”

Budget hawk David Crane, a Stanford University lecturer on public policy and former economic advisor to Gov. Arnold Schwarzenegger contended in his email newsletter Tuesday that the May budget revisions propose drawing down $12 billion of those reserves, based on his reading of the LAO report.

Further, Crane says the state needs to have $50 billion in reserves to guard against the state’s revenue volatility going on an estimate in a DOF report in January 2020 that estimated that could be the shortfall in a recession similar to the 2000 tech crash. But Crane also said that given the state’s wide revenue swings, because of its dependence on capital gains and income taxes, it’s virtually impossible to reliably predict revenue in California.

The state has generally received high marks from the rating agencies for its work to stabilize its finances since the 2008 recession, but ratings analysts always mention the state’s revenue volatility as a concern.

The state’s tax structure — and its dependence on taxing capital gains from higher wage earners — earned it the distinction of being the state most dependent on capital gains in a March 2020 S&P Global Ratings Report.

It holds ratings of AA, Aa2 and AA-minus from Fitch Ratings, Moody’s Investors Service and S&P Global Ratings. All have stable outlooks.

The LAO also recommended the Legislature prioritize fewer new proposals for spending, so it can be make substantial progress in a few key areas. The May budget revisions includes 400 new proposals, according to the LAO.

“The surplus, in combination with the federal fiscal recovery funds, represents resources equal to about half of pre-pandemic General Fund budgets,” Hollingshead wrote.

She questioned whether state agencies even have the capacity to allocate that much new funding in a timely and effective manner.

The Legislature also has less than a month to its June 15 budget passage to weigh all of the new programs, she said, recommending that the Legislature delay “some of those decisions and offer options for doing so.”

States have until 2024 to spend money from the federal government’s recovery funding; and LAO Gabriel Petek had recommended in a report ahead of the May budget revisions that lawmakers consider spreading out spending.